To what extent should investors worry about Turkey?
Turkish assets have been under severe pressure, with the Turkish lira depreciating by 42% against the U.S. dollar this year, down 22% this week alone. In addition, year-to-date, local equities are down 19% and the 10 year USD government bond yield is up 309 bps to 8.4% since January 23, 2018, the earliest available trading date this year.
The Turkish economy is finding itself in the midst of a perfect storm, in the following ways:
- Turkey is an importer of oil, with net imports representing 0.7% of GDP. As oil prices climbed since their 2016 lows, Turkey’s inflation climbed and its current account deficit widened, leaving it vulnerable to outflows of capital.
- As sentiment soured towards emerging markets this year, Turkey was indeed seen as one of the more fragile EM economies, with a 6% current account deficit as a percentage of GDP and with 39% of its government debt denominated in U.S. dollars.
- As pressure has continued to intensify on its currency and markets, the Turkish government’s response has been seen as inadequate by investors, as the central bank has not meaningfully raised rates and the government has yet to present a comprehensive economic plan to deal with the turmoil.
- The last straw was a worsening of relations with the United States, as the U.S. imposed sanctions last week on some Turkish officials over a diplomatic issue and today proposed doubling the tariffs on Turkish exports of steel and aluminum to the U.S. In order to restore investor confidence in Turkey, an improvement in relations with the U.S. would help; however much more needs to be done on the monetary and fiscal side as well.
Turkey represents only 0.6% of the MSCI Emerging Markets index and 5.9% of the J.P. Morgan Emerging Market Bond Index Global, thus U.S. investor exposure to Turkey is likely limited, especially on the equity side. Crucially, other EM countries are in a much better position to weather this moment of negative investor sentiment towards the EM asset class. In aggregate, EM countries run a very small current account deficit of -0.1% of GDP, have only 8% of their total government debt in foreign currency, and have inflation rates at or near central bank targets. As a result, investors should remember that Turkey is not representative of the rest of the EM universe.
Today, global markets were under pressure as investors worried about other possible contagion. While Turkey makes up a small percentage of the global economy and financial markets, investors are worried about the issues in Turkey causing damage in other markets around the world, particularly Europe. European banks fell 2.4% on Friday as the European Central Bank raised concerns about bank balance sheet exposure to the deteriorating financial conditions in Turkey.
However, the overall exposure of European banks to Turkey is fairly limited. As seen in Exhibit 1, Spanish and Italian banks are most exposed to the Turkish financial system, with 4.5% and 2.1% of total balance sheet exposure to Turkey. These numbers are relatively small and the rest of the global banking system has very little exposure to Turkey. Furthermore, European banks are in a significantly stronger financial position than they were a few years ago. The tier 1 capital ratios for European banks has risen from 10% in 2012 to over 15% in 2018, meaning that European banks can handle Turkish financial issues. Therefore, the risk of contagion in Turkey destabilizing the wider financial markets via the banking channel is fairly limited.
EXHIBIT 1: BANK EXPOSURE TO TURKISH COUNTERPARTIES BY COUNTRY
This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields is not a reliable indicator of current and future results.
J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. This communication is issued in the United Kingdom by JPMorgan Asset Management (UK) Limited, which is authorized and regulated by the Financial Conduct Authority, Registered in England No. 01161446. Registered address: 25 Bank Street, Canary Wharf, London E14 5JP.